Direct costing vs. absorption costing: A historical review

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Gyan Chandra and Jacob B. Paperman
MIAMI UNIVERSITY
DIRECT COSTING VS. ABSORPTION COSTING: A HISTORICAL REVIEW
The purpose of accounting has been generally described as the process of providing information to owners, creditors, governmental regulatory agencies, and operating management. "In a broad sense accounting has one primary function: facilitating the administration of economic resources. This function has two closely related phases: (1) measuring and arraying economic data; (2) communicating the results of this process to interested parties."1 Of primary concern is the fact that the users of the accounting information are involved in the decision making process. However, they have different in-terests and objectives. Accordingly, the same information may re-quire varied processing and summarization to meet the needs of each class of users. Various accounting practices, based on the same accounting concepts and principles, have been developed to satisfy the multiple and changing needs of the users of accounting reports. Direct and absorption costing are two such accounting practices. Controversy continues to exist as to which of these two costing methods is better for decision making purposes and for re-porting to the users of accounting information. The objective of this paper is to dwell upon the historical nature of the controversy and build a case for a method of costing that rests on economic logic and realities of the market place.
Direct Costing vs. Absorption Costing—In Historical Perspective
"One of the major problems in determining the valuation of manu-factured assets is the decision regarding which costs are relevant to future periods and thus should be included in asset valuation and which should be charged against current income."2 This is the crux of the controversy between direct costing and absorption cost-ing.
In the early stages of accounting development the financial ac-countants used to determine product costs by charging all manu-facturing (factory) costs—direct and indirect overheads—to the